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Back in March - when inflation was beginning to reach a point of serious concern - CEO of SpaceX and Tesla (TSLA) and recent acquirer of Twitter (TWTR) Elon Musk tweeted:
As a general principle, for those looking for advice from this thread, it is generally better to own physical things like a home or stock in companies you think make good products, than dollars when inflation is high.
At the time, we went on to discuss why real assets outperform in an inflationary environment, namely that:
- Inflation increases real asset replacement costs and cash flows
- Negative real interest rates provide a double boost to real asset investors.
However, since then inflation has gotten only worse, with year-over-year U.S. CPI growth accelerating to 8.58% in the most recent reading and no signs of it slowing anytime soon. In fact, Elon Musk claims inflation is much worse than is being reported in the official CPI numbers.
With supply chains still struggling with major issues, the war in Eastern Europe raging on, and major global economies teetering on the brink of recession, the global economy is on the verge of moving from inflation and growth to stagflation.
Back in March we told readers that we were buying utilities (XLU), infrastructure (IFRA), energy midstream (AMLP), gold miners (GDX), and REITs (VNQ) hand-over-fist. The specific picks that we outlined in that article were: Enterprise Products Partners (EPD), W. P. Carey (WPC), Vistra Corp. (VST), Barrick Gold (GOLD), and Patria (PAX).
Since then, they have all outperformed the market with an average performance of 4.61% over a span in which the S&P 500 (SPY)(VOO) has fallen by 7.46%:
Moving forward, the following stocks are among our top picks:
#1. Energy Transfer (ET)
ET is arguably the top income growth stock buy in the market today thanks to the strong macro tailwinds for the business, the fat current yield, the massive remaining distribution growth runway remaining ahead of it, and the dirt cheap valuation.
Energy has proven to be a remarkable inflation hedge over time and ET's export-oriented assets are also poised to benefit from soaring U.S. energy exports in the wake of the war in Eastern Europe and growing demand from Asia.
On top of that, ET's inflation-linked contracts are poised for a major boost this summer as per comments by management on ET's Q3 2021 earnings call:
In most of our contracts, certainly, in all of our liquid contracts around our transportation and fractionation and around our crude contracts, we have an index. It's typically a FERC index... next July we expect that to move up significantly. We've heard as much as 5% or 6%, and we do have those increases in the vast majority of our rig contracts as well as in many, if not most, of our gas contracts. So we do have, whether it's the CPI index in our gas contract or the FERC index and our liquid contracts, we do have that in the majority of those, and we'll benefit from -- or at least not be harmed by the inflationary growth in costs.
With a juicy 19.2% distributable cash flow yield and a forward distribution yield of 6.73% (that is set to grow to a 10.5% yield on current cost in the near future as per recent management's remarks), ET looks like an income investor's dream pick.
#2. Virtu Financial (VIRT)
VIRT recently reported its Q1 FY2021 results and the stock promptly plummeted due to the fact that adjusted net trading income fell by a whopping 30.6% year-over-year. However, even with the drop, the company generated GAAP EPS of $1.27, which translates to an annualized price to earnings ratio of just 5.6x, making the stock incredibly cheap in our view.
Furthermore, the company continued to buy back shares hand-over-fist during the quarter with a total of $287 million in buybacks. In a little over five quarters since initiating the buyback program, VIRT has reduced the outstanding share count by 9% at an average price of $29, which is approximately the current share price of the company (and a price that we believe unlocks significant value for shareholders). When combined with the solid dividend and organic growth initiatives, VIRT offers investors an attractive total return package.
While it is easy to get discouraged that lately VIRT's stock price has not served as the volatility hedge that it is expected to be, it is important to remember three points here:
(1) VIRT is a capital-light business that should be able to weather inflation headwinds very well.
(2) The business is throwing off a ton of cash, enabling it to deliver strong shareholder capital returns via buybacks and dividends while we wait for the market to assign it a proper valuation multiple. As patient long-term income-focused investors, this matters to us far more than short-term price performance.
(3) Recall that VIRT's stock price has often lagged market volatility. In fact, when we bought shares of VIRT back in January, the stock was severely lagging the volatility in the stock market, leading one member to remark: "Any idea why VIRT is not doing what it is expected to do ….which is going up in a down market." Sure, enough the stock shot 32.2% higher in the near immediate aftermath, rewarding us for our focus on fundamentals.
We believe that it has a high probability of doing so again, especially with inflation and geopolitical concerns leading to increased market volatility. Now is a great time to buy the stock on the cheap. You can read our exclusive interview with the company here.
#3. Hanesbrands Inc. (HBI)
Similar to VIRT, HBI stock plummeted after it reported its Q1 FY2021 results due to management comments implying that COVID-19, inflationary, foreign exchange, and supply chain headwinds are likely to negatively impact profit margins through at least the rest of 2022.
However, HBI is doing an admirable job of fighting through these headwinds thanks to a combination of efficiency captures and price increases that leverage its brand power. As a result, management was able to beat analyst expectations on both the top and bottom lines in Q1 and reaffirm its 2022 sales, operating profit, and earnings per share guidance, which is quite remarkable given the headwinds facing the business.
HBI also repurchased ~0.5% of outstanding shares during the quarter on top of the attractive dividend, equating to an annualized shareholder return yield of over 6% and is likely to buy back more shares in the coming quarters.
The CEO emphasized over and over again that the company was remaining focused on the long-term and is doubling down on the Full Potential Plan, which includes aggressive investments in the brands and sustainable organic growth along with finding new operational improvements.
Overall, HBI continues to make progress and the new CEO continues to impress. We are happy that he purchased a significant amount of shares himself in Q1 and that the company is deploying free cash flow towards buybacks at current levels. Despite enormous headwinds - which have driven the massive selloff in the stock in recent months as well as today - HBI continues to deliver strong results while also investing in the long-term potential of the business. We believe that HBI will emerge from the current headwinds a stronger company and as a result we remain very bullish on the stock.
While HBI is not an inflation proof stock, it is weathering the headwinds admirably well and is positioning itself to emerge from the current environment a much better company. Inflation is giving investors a remarkable opportunity to buy this cash cow at a steep discount. You can read our exclusive interview with the company here.
Investor Takeaway
With inflation soaring and ravaging the stock market, investors have tremendous opportunity to capitalize on Mr. Market's irrational moodiness by buying up stocks in high yielding, high quality businesses like HBI on the cheap that are poised to deliver outsized long-term returns. Furthermore, stocks like ET - which are thriving in the current environment - remain deeply discounted and still offer incredibly high yields. Last, but not least, stocks that profit from market volatility like VIRT are on fire sale and offering a compelling dividend yield at the same time even as the company is buying back its stock hand-over-fist.
As the world's richest man - Elon Musk - says: when inflation is high, buy physical things like real assets and stocks in great businesses.
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